Bargains in Muni Bonds Conflated With Distressed Names

By Michael Aneiro

It pays for muni investors to pay attention to names. Particularly to bonds that may share the same name as a distressed municipality but aren’t directly linked to it. Retail investors often lump the two together and sell both, leaving bargains for savvy investors. Mike Cherney writes in today’s Wall Street Journal how investors can play such discrepancies:

Bonds tied to a distressed city often take a hit when plummeting tax revenue or outsize pension costs strain the budget. But some bonds that bear a city’s name are in better shape than others. As prices on those bonds decline, some investors are scooping up this debt at comparatively high yields. This guilt-by-association strategy has become more enticing as money managers struggle to find yield at a time of ultralow interest rates.

Cities across the country continue to struggle to balance their budgets because property-tax collections are still on the decline. Professional investors are capitalizing on the situation by identifying bonds backed by revenues that are insulated from a city’s general accounts. They are able to quickly pick out these bonds thanks to research and legal staffs, resources that aren’t usually available to individual municipal-bond investors. In fact, it often is panic selling by these mom-and-pop investors that gives fund managers their chance to pounce.

The story cites a fund manager who bought $70,000 of sewer bonds issued by Fresno, Calif. – a city facing falling property values, high unemployment and a junk credit rating – that yielded 3.04%, far higher than the 0.60% yield on comparable Riverside, Calif. sewer bonds with lower ratings. Holders of these specific bonds are insulated from Fresno’s tax-revenue woes because their debt is specifically secured by revenue from the sewer system. Such “essential-service” municipal bonds are considered among the safest, and the sewer bonds carry higher credit ratings than the city.

But such purchases can require some explaining, as the story explains:

Rick Ashburn, the chief investment officer at Creekside Partners in Lafayette, Calif., recently bought $100,000 of 10-year bonds yielding about 4.75% issued by the Stockton East Water District. It is an independent entity that sells water to the city of Stockton, Calif., which filed for bankruptcy protection over the summer, and another utility. He estimated a similar bond without the Stockton name would yield about 3% to maturity.

“A client called and said, ‘Oh my god, what did you just do? You bought me a Stockton bond!’ ” said Mr. Ashburn, whose firm manages $70 million in municipal bonds. “We had to explain that, ‘No, this isn’t a Stockton bond. It just says Stockton on it.’ It’s a chance to get dramatically higher yields than you could otherwise get.”